Inflation Targeting: Which Tools Work in Kazakhstan

Here is my amateur opinion on inflation targeting.

In essence, inflation targeting means achieving set inflation parameters through various methods of influencing the economy. Most of these methods are within the purview of the National Bank.

The most important thing is to understand how each of the proposed methods affects inflation. Some methods will not have the desired effect in Kazakhstan when changed. An example is changing interest rates in a period of limited liquidity: there is no point in changing rates if there is no liquidity. The exchange rate of the tenge, by contrast, has a significant effect on inflation in the country. I would like to see a mathematical or at least a statistical model of the impact of each method on inflation.

Broadly, inflation can be influenced through demand management or supply management. The main methods (those known to me) are as follows. Each of them could be broken down into sub-methods, but we will not go down that path.

Changing consumer lending by providing liquidity. Second-tier banks lend money to households, who use it to buy cars, real estate, household appliances and so on. When inflation is high, liquidity is restricted and consumption falls. However, this affects economic growth, since lower consumption means lower production.

Changing supply in the country through liquidity. This is much the same as the first method, except that liquidity is used to regulate production (working capital and investment loans).

Changing consumption through interest rates. Higher rates mean less demand for loans, which reduces inflation. But this model has a flip side: rates for consumers and producers move together, so when rates rise, producers' costs rise as well. That pushes up the price of goods and increases inflation.

Changing government spending. Higher government spending stimulates demand in the country and increases inflation. In a crisis, however, government spending can support economic growth. In addition, when government demand is high, supply is stimulated as well through government orders.

Changing fiscal policy. For example, a higher tax burden raises production costs, which affects the final price of goods. On the other hand, offering various deductions under high personal income taxation stimulates consumption, which is good for the economy but raises inflation. A lower tax burden reduces costs and lowers inflation. In general, fiscal policy is a separate topic, and so far we have not used it at all for government regulation of the economy.

Changing the exchange rate. When the US dollar moves against the tenge, we all feel inflation immediately, because consumer goods are mostly imported. In a period of rapid economic growth, to contain inflation we strengthen the tenge against the dollar. Imported goods then become cheaper, which pulls down prices inside the country and reduces inflation. We all remember the dollar falling during the boom of the mid-2000s. But in a downturn or stagnation, to support domestic producers we, alas, cannot devalue the tenge, because we would then breach the inflation expectations corridor, which is inconsistent with the inflation targeting policy itself. More precisely, we can, but not by much: we always forecast moderate inflation, while the depreciation that would suit our producers would have to be large. This is due primarily to the fact that Kazakhstan is a commodity-based country that mostly consumes foreign products and exports raw materials. Many commodity-based countries peg their currencies to the US dollar.

Protectionism, or customs regulation. The cost of imported goods is regulated by changing import and export duties. The downside of this method is that it does not foster a competitive environment, though for infant industries it can be a good tool. Unfortunately, this tool is now in the hands of the EAEU.

Antimonopoly regulation. Regulating the prices of monopolies can also influence inflation in the country. Incidentally, it is largely thanks to this policy that inflation was contained in the short term during devaluations.

Changing currency regulation. This makes it possible to regulate access to international finance, which also affects demand and supply.

The main problem for Kazakhstan is that inflation targeting emerged here as a term specifically as an alternative to currency regulation. In other words, the National Bank will regulate inflation rather than the exchange rate, and if the tenge weakens but stays within the corridor, the National Bank will allow it to weaken. In principle, this is correct and sensible, but only in countries where there is:

• High localization of production, so that most of the goods consumed are produced domestically.
• Reliable inflation data. I do not put much trust in the information from the statistics agency. The methodology is opaque and confusing. When it feels as though prices have risen by 20%, and the figure reported is 7%, you start to wonder whether your perceptions are quite right.
• A developed financial and stock market with equal opportunities for all financial agents, not just for a select few.

I do not want to criticize the program proposed by the National Bank. I am sure there is much good in it, but what matters in this situation is which principles are applied in implementation. If it is a mere declaratory rollout, it will be much like the introduction of the currency basket for determining the tenge rate a year ago.

One thing I really could not understand is how the Monetary Policy Committee differs from the Board of the National Bank. It would be logical to include independent experts in the Committee.

I would also like to see the government's fiscal policy, because the story with VAT and the sales tax is not entirely clear. And there is much in our tax legislation that needs to change, from the crooked system of taxation of subsoil users to personal income taxation.